Tuesday, March 6, 2018

"Why Is No One Listening to Jeremy Grantham?"

From Institutional Investor:

The notorious bear and GMO co-founder has “touchy-feely” evidence of a market bubble in the making — and a battle plan.

When legendary investor Jeremy Grantham heard a colleague
recount sharing a bus ride from New Hampshire to Boston with a young
woman who wanted to sell her house to invest in stocks, alarm bells went
off. This, he thought, signaled the euphoria seen before a market
crash.

It was late January, and the U.S. stock market had roared
into 2018 posting new highs for six straight trading days. The woman
wasn’t satisfied with her $300,000 house crawling up a few percentage
points in value when stocks
had risen by double digits annually since 2009. “She wants to be in the
market,” says Grantham, who co-founded GMO in 1977, from his office on
the Boston Harbor. And she was reaching for a 20 percent return.

To the mind of Grantham, who called the major bubbles of 2000 and 2007, this story was more evidence of a “melt-up”
in the stock market, which he had warned about just weeks before. This
is when the market shoots up after several years of rising prices,
signaling the final stages of a great bubble near to bursting, according
to the 79-year-old.

U.S. stocks soared in 2017, with the S&P
500 index returning 22 percent, and continued to push higher this year
before volatility shook the market in February. After the index tumbled
by 10 percent, from an all-time peak on January 26 to this year’s trough
on February 8, analysts expect new highs in 2018.

As a value
investor, Grantham has done plenty of homework on the stock market over
the past half-century. He was not alive to witness the 1929 bubble, but
has studied it closely. It’s true that data can flash warning signals
that a bull market is heading for a steep fall, but it’s the
“touchy-feely” — the traces of euphoria in ordinary situations — that is
particularly telling, Grantham says.
“The stories are more
important than the price,” he says. “Be prepared for the fact that the
market can break your heart on the upside.”

The psychology of a bubble can be incredibly painful for asset
managers with careers at stake, according to Grantham. In normal times
it’s reasonable to believe clients are concerned about how well a
manager can handle a downturn. “But in a bubble, forget it,” he says.
“Clients care much, much more about underperforming all their friends on
the golf course.”

Grantham — GMO’s chief investment strategist — has a decadeslong grasp of markets to inform his bets. His office on Rowes Wharf,
with its art, its sofa, and a balcony looking out to the harbor, has a
lived-in feel redolent of history and study. Newspapers are spread about
the room, and beyond his desk are several sculptures, including a
Buddha. A photograph of the destruction left by Boston’s great 1872 fire
leans against one wall.

In a melt-up, it’s easy to stand out for
lagging performance. While everyone is bragging about their gains,
sitting on a pile of cash can cost asset managers their clients, so many
managers stay invested. “They’re leaping around with great energy,
comparing notes,” says Grantham. “They simply can’t stand that one or
two of their rivals are playing the game and making a lot of money and
making them look bad.”

When stocks plummet, the situation is
markedly different. Everyone becomes “catatonic,” trying to avoid
discussing how much they lost, he explains. No one gets fired in that
moment — clients wait until the event concludes before sorting through
what happened.

Grantham warned in a January 3 letter that, in his
“very personal view,” investors should brace for a melt-up in the near
term. Prudent preparation for a downturn will take a psychological toll,
he notes. Know how much pain you can stand because the average client
is going to lose patience. “The market, instead of going down, not only
goes up, but goes up at a faster rate than normal,” he says. “You’re
going to feel dreadful.”

Seventy percent of fund managers view the
global economy as “late-cycle,” the highest level since January 2008,
according to a Bank of America Merrill Lynch survey conducted in early
February. These managers expect, on average, an S&P 500 peak of
3,100.

The index, which measures the performance of large U.S. companies, has largely recovered from its early-February drop.

“We
thought a pullback would be normal,” says Jill Carey Hall, an equities
strategist with Bank of America Merrill Lynch. Since 1930 the U.S. stock
market has fallen by at least 5 percent three times a year on average,
she says, noting that such a drawdown hadn’t previously happened since
June 2016.

U.S. stocks haven’t looked cheap. Before their plunge
the S&P 500’s 12-month forward price-earnings ratio traded around a
15-year high of more than 18 times, according to Hall. In November the
P/E ratio was 18.3 times, the highest since May 2002, she notes.

“We
had so much excitement in January, there’s at least some chance that
this thing will blow up now — game over,” says Grantham. “But I think it
will recover and go to new highs.” Grantham expects the melt-up to
eventually lead to a 50 percent drop in the stock market, if not more.
If the market came crashing down this fall, he says, “it would look like
a perfect bubble.”

Instead, they tend to fall by 2 to 3 percent a month over their
entire duration, with most of the decline coming in the last 40 percent.
Bear markets begin by “lulling in greater fools with peaceful, minor”
declines, says Fisher. “Nobody gets lulled by what just happened.”...